EchoStar Corporation (SATS) Q2 2008 Earnings Report, Transcript and Summary

Good afternoon. My name is Jessica, and I will be your conference operator today. At this time, I would like to welcome everyone to the EchoStar Corporation quarter two 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator instructions) Thank you. Mr. Keiser, you may begin your conference.

Thanks, Jessica. Well thanks for joining us. My name is Jason Keiser. I’m joined today by Charlie Ergen, our Chairman and CEO; Bernie Han, our CFO; and Stan Dodge, our General Counsel. Before we open up for some Q&A, we do need to do our Safe Harbor disclosures. So for that, we’ll turn it over to Stan.

Good morning everyone. Thank you for joining us. We invite media to participate in listen only mode on the call and ask that you do not identify the participants or their firms in your reports. We also do not allow audio taping and ask that you respect that. All statements we make during this call that are not statements of historical fact constitute forward-looking statements, which involve known and unknown risks, uncertainties, and other factors that could cause our actual results to be materially different from historical results and from any future results expressed or implied by such forward-looking statements. For a list of those factors, please refer to the front of our 10-Q. All cautionary statements we make during this call should be understood as being applicable to any forward-looking statements we make wherever they appear. You should carefully consider the risks described in our reports and should not place undo reliance in any forward-looking statements. We assume no responsibility for updating any forward-looking statements. With that out of the way, I'll turn it back over to Jason.

Thanks, Stan. Jessica, we are just going to go straight into Q&A, so you can open up the lines.

(Operator instructions) The first question comes from the line of Kit Spring. Kit Spring – Stifel Nicolaus: I have several questions. Can we start with why the sales to DISH Network were down so much sequentially? Is there a natural seasonality? Was there some kind of pricing or volume change, or did it have to do with inventories? That is my first question.

Okay. That’s a good question. Really kind of two factors. One is obviously DISH leases capacity. So to the extent that the seasonality has turned as high in the summer, so they have more boxes that come back from a lease perspective and therefore require less boxes from that perspective. And also, if you just listen to DISH caller gross describer adds, we are not as high as they were this time last year, so that had a negative impact. The other probably more significant impact, which is kind of – which is good news-bad news is DISH has been migrating and you saw following announcement of Turbo HD. They've been migrating to the MPEG4 technology. So the bad news about that is as you make a transition to MPEG4 technology, you need – you want to make sure that you have less MPEG2 boxes on hand. The good news is that by going to MPEG4 technology, DISH is in a situation it has to go to a slightly higher more expensive box, more technically advanced. And as you upgrade people, you have increased demand for those set-top boxes regardless of what your gross additions are. So I think SATS is well positioned in – it’s well positioned and with DISH in an MPEG4 transition, but it’s also well positioned with (inaudible) other customer who obviously will make the same kind of decision at some point, if they haven’t already, to transition to MPEG4, and potentially, other customers around the world who want to take advantage of an MPEG4 type technology.

Okay. And then on targeting new customers, which I think I think is the key to the equity here, who do you think realistically is your best chance on both the set-top box side and the fixed satellite services side as far as major customer?

Well, on the satellite – on the set-top box side, I think the – there’s any number, but probably from a customer perspective, probably international customers might be the – I guess domestically, cable companies would tend to be – would be tougher sales in general because they perceive the DISH influence, which isn’t there, but they perceive that right. Obviously, DirecTV is competitor to DISH, so that’s a little tougher. Internationally, you don’t have that dynamic. So that’s perhaps more likely top scenario, and then obviously, it’s possible for phone company-type business in terms of set-top boxes that phone companies are going to go look for the best price value regardless of where it’s going to come from, so they’re not quite as emotional about it probably as most cable companies might be. And that’s not to say that SATS is going to give up on the cable industry. We think that we can still make a great box in the cable industry even though it might compete with other companies. From a fixed satellite service business, that business could come from anywhere. I mean that business, there’s – obviously, we have an abundance of the capacity today. There’s not a huge amount of capacity out there today. And there are new people, particularly, as you look at HD and other forms that are using capacity. So there’s opportunity out there, and we’re a little bit new to the business, but we do offer – we offer value add that other people can’t. We have set-top boxes. We have encryptions, sys services, we have installation and service networks, we have good backup capability. And we just got to go and find those customers who have gone – lot of customers on long term contracts and we can get customers as those contracts roll off, and we can get new people to enter the business. But, there’s no one source that business is going to come from. It’s going to come from a number of companies.

Okay. Are there particular satellites that you think are much more attractive or likely to get additional customers there?

Well all of our satellites are pretty attractive. They really are.

Okay.

One of the interesting things, did it cost a lot more money to build a satellite today? There’s huge amount of inflation in the satellite industry, whether it be from launch services or whether it be construction of the satellite, a lot of the parts are made overseas, and the value the dollars has really increased cost of the satellite. So the fact that we have satellites up in outer space that were bought or leased at fairly low prices should put us pretty well positioned there. But the satellites are all state of the art and very good and very powerful. There’s upside for our business there and we think we’ve got the right guy running that business, and we’re working hard to grow it.

I noticed you lowered the potential write-down under existing satellites from $300 million to $250 million to $200 million this quarter. What gives you the confidence or what changed to lower that liability?

We removed the – I think if you saw our previous disclosure, we have three satellites in there, which were Echo IX, AMC 15, and AMC 16. And we updated our analysis based on current cash flows related to all three and we think the risk of Echo IX being written down is de minimus and thus we removed that from the previous amount.

Okay.

We made some – it may not show up in the total numbers yet, but we made some – I guess we made some improvement in the second quarter obviously in that side of our business.

Okay. Any update on the potential for a write-down at CMD or what you’re going to do with that satellite?

No update there. Certainly, still risks remain there, but we think there’s also – satellites today would cost a fair amount more money to build than we think there’s opportunity there. There aren’t a lot of satellites with that design around, and so we think there are unique situations around the world. And we just haven’t gone through all the analysis – and the – but we sure – probably will decide in the next three months exactly what we’re going to do there.

Okay. Do you expect to have to write down the TerraStar [ph] assets as the stock price as lower?

Well I think that’s a possibility. I mean if --

We’re accounting for – as we talked about in the 10-Q, we’re going to be accounting for TerraStar on a fair market basis. So as there are changes in the price of the stock that we own or the debt that we own, they will be reflected quarter-by-quarter going forward.

Okay. Can you talk about the impact of TiVo to SATS? You talked about it at DISH. How would it differ at SATS?

It’s a bit different. For SATS, it's opportunity, right? For DISH, the risk is you have existing customers that might loose part of their functionality, right? So that’s kind of consumer risk where you – in theory, you don’t have to replace the box, right? That makes sense. This is kind of a crazy thing I didn’t answer in the last call but I think TiVo's position as well – you can send the guy or you can send somebody at 211 box today but if you had the 211 box, you have to turn it off, and so you can send it back to him and he'll send a new one, that’s okay, but you can’t use an existing one that you have if you download new software to it. So kind of a conflicting thought process but DISH has got consumers. That’s their kind of risk. SATS is an opportunity. There’s not – they don’t have consumers to deal with directly but what they do have is to think TiVo was successful is inventing the DVR. And the only people in the world that have access to DVR and the only people that you can – you have to – everybody would have to license from them. If everybody has a choice of licensing from TiVo or from SATS because SATS was found not to violate TiVo's patent, then it’s an opportunity for them to go out and build set top boxes for people and include the DVR functionality for people where it gives them an option not have to pay TiVo for a license. So it’s a great opportunity for them and certainly it’s a high-risk reward. There’s not much risk for SATS, but there’s high reward there. Kit Spring – Stifel Nicolaus: I’ll let someone else go. Thank you.

Your next question comes from the line of Chris Summer [ph].

Hello. I have a few questions also. One, I noted in the 10-Q that DISH is currently building satellites that may cause them to no longer need EchoStar satellites. I was just curious to learn more about the background there and why DISH would spend money on satellites that would displace EchoStar satellites, as I was understanding, that was kind of the motivation for the spin-off was to put that capability at EchoStar?

Well, I guess I’d say it a little differently. DISH – excuse me – where DISH can build a satellite, owns a (inaudible), it can build a satellite less expensively that they can build it from – get it from SATS. Their Board may make that decision. A variety of factors to look at, but who owns the orbital slot [ph], what’s the actual cost of building a satellite and what are you going to do with your cash, do you have alternatives for your cash? From a SATS perspective, they’re not going to – they’re going to build satellites but I think they’ve got a customer. And at this point – wow, DISH could always decide at some point they don’t want to lease capacity from SATS. I think from a profit point of view, when you got customers looking at – once you get a number of customers looking at a particular satellite location, it’s very difficult economically for somebody to decide they don’t want to lease that capacity. It’s possible and they certainly have that optionality. But from a SATS perspective, we’re pretty confident that once we get people looking on our satellites, it’s more difficult for people to leave us because there's a cost to changing those guys out.

Okay.

I think the other thing that I would try though in there is the fact that DISH lost the Echo II satellite last quarter’s deposit for SATS in that capacity side.

Got it. Next question would be, with respect to the binding purchase orders Bell Expressview (inaudible) from you guys? The sales from this quarter, were those above and beyond the binding purchases or the minimum amount they were required to purchase or are they kind of purchasing at a previously contracted rate?

I guess, I’d let Expressview answer that question, but I'd generally say that Expressview is buying. At this point, the relationship is good there and they’re just buying – they’re buying based on the needs that they have. And I don’t know that they’re necessarily buying for a contractual number. I think their business is good enough, but that’s not an issue but they'd probably be able to answer that. I don’t know – I’m not privy to all information, so you’d have to really ask them.

Got it. I guess so far this year, have you guys been marketing internationally, and if so, in what countries?

Well, we have some business in Europe. We have some business in South America and we are marketing there and we have pretty – we have some marketing efforts now in Asia. So, we pretty much solidified kind of our sales efforts internationally. Those sales lead times are fairly long and then once you sell it, you got to engineer it. So you got kind of two factors working there that extend lead times maybe more than the marketplace really understands in the sense that you got to sell it and then you got to go build it. And most international designs are somewhat different than US designs.

Yes.

So it’s not – most of the time we can’t take an off the shelf US design and go plop it down somewhere because the voltage is different, the modulation scheme is different, the encryption is different, and so forth. So those are long lead times that we are really putting a lot of effort in place to sell. And I think that it is a key strategic focus for SATS is to continue to build their customer base beyond DISH.

Right.

And that would include the international business, the fixed service business and the setup box business.

Got it. And then last question, if you guys start marketing MPEG4 boxes to DISH, are those going to be subject to the same cost plus margin agreements until the expiration or will those be outside of that agreement?

They are covered by the current agreement. We already sell MPEG4 equipment to DISH today.

Okay, got it. Thanks very much.

Your next question comes from the line of Richard Murawczyk. Richard Murawczyk – Knott Partners: Hi, it’s Richard Murawczyk of Knott Partners. I’m just calling to find out how does the MPEG4 transition change transponder loading? Should we expect to see an increase in the utilization of the transponders at the existing set fleet?

Well, it – MPEG does a couple of things. One is you normally need more power on your satellite to give – to the same satellite dish size so it makes the need for more power for satellites and again SATS is pretty well positioned with powerful satellites today. Second thing it does, it does tend to give you anywhere from a 50% to a 100% efficiency gain on the actual satellite transponder itself. So, again, that’s a good news/bad news situation from a SATS perspective – from a fixed satellite service biz perspective. It frees up capacity so it makes more capacity out there so it makes a little tougher to sell. On the other hand, you can sell capacity cheaper and put into smaller bits and more people getting it on the market place. That’s a dynamic that tend to be neutral over a period of time. But what it does do it makes – even though the MPEG4 products today costs more than MPEG2 products, the efficiencies that you gain on the other side, in terms of satellite capacity usage makes it means you can invest more on MPEG4 boxes. Second thing is MPEG4 boxes are the technology of the foreseeable future from a modulation scheme so therefore you can invest for the long time – long haul. And so that’s a real positive for SATS because it means that the people around the world are going to start looking at MPEG4 as being more efficient from a satellite perspective and having a much longer in terms of technology and therefore people will start migrating. They’re doing it today and I think that it can accelerate that people will migrate to MPEG4. And as they do, the set tops boxes are out of business because SATS has many MPEG4 designs including DVR designs and now, Sling design. They should be competitive in the market place. Richard Murawczyk – Knott Partners: The offset to freeing up the capacity, I guess, is that your – DISH is rolling out HD in more locations, so should we see increase in transponder utilization or decrease in transponder utilization?

I guess we did see an increase in satellite utilization for sure, and I define it from a – I assume from a DISH respective that they wouldn’t want to have capacity out there that they’re not using. Richard Murawczyk – Knott Partners: Say that again.

Well, I don’t think any user of satellite capacity, whether it be DISH or any body else, wants to have auto [ph] capacity because you make revenue on auto capacity. So, capacity utilization of the transponder leasing should go up because it means – it takes a little longer that can mean, for you to say I’m in new capacity but that’s a different question. The result of all of the capacity you leak today you got to utilize as efficiently as you can and i.e. you want to put on a 100% utilization but then drives you to need more satellite capacity in the future but if you have a longer time than you need it because MPEG4 gives you better efficiencies. So, I know I’m not answering – maybe not answering the question but the MPEG4 works both ways and it’s kind of neutral from a capacity point of view in terms of lease and capacity of people. It means you’re more efficient then people don’t need as much capacity but brings new interest into the market place whether it be for HD or be any other business because they can – if the transponder was a $100,000 a month and you could put ten channels on it, that’s $10,000 a month, you can put twenty channels on, it’s $5,000 a month and so there’s a lot more users at $5,000 a month than there are in $10,000 a month. And so, it brings new people into the business. Suddenly it makes sense for a business TV perspective to lease more capacity. Suddenly it makes more sense to send the proprietary signal for your 20,000 locations across the United States. Richard Murawczyk – Knott Partners: Right.

Suddenly it makes more sense to switch all your capacity from a bunch of landlines to satellites and those dynamics tend to neutralize each other. Richard Murawczyk – Knott Partners: Okay.

And I remember when you said channel per transponder, right? Now we have ten. Now we’re going to twenty. Richard Murawczyk – Knott Partners: And then in the commitments and contingencies portion of the 10-Q, there’s been a significant increase in the purchase obligations of EchoStar Corporation so I assume it’s for set-top boxes, how quickly does that work through the income statement?

Can you take that?

Yes, I’m sorry. You’re referring to the commitment section under –? Richard Murawczyk – Knott Partners: Yes. The commitment and contingency section, so when March 31st you had purchased obligations of $632.5 million, today’s 10-Q was a little over a billion dollars of purchase obligation. I think that’s all set-top.

Okay. Yes, that’s one is related to satellite and you have seen it in 2008, this is where that shows up.

So that set-tops – the big increase is probably satellites themselves Richard Murawczyk – Knott Partners: No. It’s purchase obligations. It’s on page 24.

I think these are set-top boxes from manufactures and the big increase was again last quarter because of the OPOs [ph] that were recreated prior to the spin-off. DISH would actually had debt obligation from buying on behalf of that. And (inaudible) that went off. Those obligations now show up on the debt side. Richard Murawczyk – Knott Partners: So that difference between 600 and million and billion is not exactly what it seems?

Probably most of that is roll-off from DISH POs but now sent to us. Richard Murawczyk – Knott Partners: Okay and this really don’t –?

But MPEG4 and the fact that MPEG4 is a bit more expensive. Richard Murawczyk – Knott Partners: Right. But that’s primarily – that’s entirely a past, there’s really no financial at SATS for that –?

Those obligations we have customers for. Richard Murawczyk – Knott Partners: Great. Okay. Thank you.

The next question comes from the line of Adam Ritzer [ph].

Two quick questions. Can you update us on your capital spending needs for the second half of 2008 and then potentially give us any view in 2009? And then my second question just had to do with your – you received about $40 million of an insurance settlement in the quarter but I read elsewhere that you don’t insure your satellites. So I’m just wondering if you don’t insure them, how did you receive an insurance settlement? Is it a runoff deal that you’d set up?

We don’t – we haven’t – we don’t normally insure satellites, we did insure this particular satellite so lucky Irish, I guess.

Yes, right.

But in this picture, partly because it was – we look at the rates and we kind of calculate what we think of fairer risk is based on the satellite in the launch vehicle and this particular case the rates were low enough that we decided to purchase an insurance. Historically in the last two or three years, we felt like that the rate was higher than the actual risk so we didn’t insure but in this case we did. You want to take the other part of the question?

Yes. With pertains to CapEx outlook, I think the schedule we’re just talking about on the previous call is probably the best place to look which we way laid out our obligations both on the satellite, from set-top boxes, and from another standpoint for the balance of 2008 in the years going forward and that’s what we – the best we know today based on commitments that have been made.

But is that more – are there new bills involved with that? Is it part of maintenance spending as well? Maybe you can give a little more color on what the satellite spending is.

The satellite obligations are simply launched in satellite payments that are based on satellites we have built here in SATS. It’s forecasting out the payments that will need to be paid for the additional satellite.

Okay. And how many new satellites does that include?

I think included in here on the SATS side, I think there are Mimic and CMB star, I mean it’s going the SATS side right now.

Is the CMB star – Is that fully paid for? Is that both – or how much more spending is on that one?

On which one?

On the CMB star.

Actually, I don’t think that’s in our future obligations right now. The other thing –

Okay. It’s not what --

The other (inaudible) we reconfigure that one.

Okay.

The other thing that should be pointed out is we also leased a couple of satellites on the side MC15 and MC16 sub payments. So it includes your obligations to MC15, MC16, includes a nimic satellite.

Okay. Then on a (inaudible) side, would you give some details over that within the fire wing [ph] that one is to be built, is it in process, maybe you can just tell me where that stands?

That is in process – It is being built. I believe it’s scheduled for end of 2009 –

I thought it was middle, I think it’s about half way done.

I think it’s about halfway constructed and scheduled for launch. I’m going to say second half of next year.

Okay. So really, that is the only one of what’s called a new-build. And then that’s it, the rest are obligations, leases, but that’s really the only new build you have gone?

That’s correct.

Okay. Great. I appreciate it. Thank you.

(Operator instructions)

Good. Maybe we don't have any questions?

Okay, there's a question in queue from the line of Gerard Halleran [ph].

Good morning again. I‘ll ask you the same question here that I asked you at the other place. What’s going on or how are the trials progressing in Atlanta? What kind of experience are you’re getting in having these devices and whatnot there?

An earlier question for those people who didn’t listen to the last call was about DVB-H and all kinds of DVB standards, but basically it’s trial that we're conducting for terrestrial satellite and mobile kind of frequencies in terms of how you might utilize those, whether it be the phones or portable devices or computers or whatever and again the trials are interesting and I think we’re excited about what we see from a technology point of view when you start to looking at OSDM type modulation schemes in general because it can use of multipath to be added to instead from an interference prospective like most modulation schemes. Additionally, you can reuse frequencies terrestrially and also via satellite if properly done. So, they are in theory, right? And so all trials have really approved those theories and understand kind of what the opportunities are? What the costs are? Most things in engineering, geophysics and sometimes straight off in terms of cost or response or efficiencies and so I think that working with people around the world who were involve in this, we try to get pretty good feel perhaps what the best mouse traps are there? That's the long term way – place for us to be in. And SATS believes that it has built that expertise that there's a role for it to play and in terms of that technology, in terms of building devices whether those be portable devices or said top boxes or whatever, can use those kinds of different modulation transmission schemes and you have to invest on your R&D to figure it out. That's part of what we do. The trials will continue for a bit longer and then I think we’ll probably have to make some decisions.

I guess not (inaudible) company, so typically it wouldn’t have any – in general, wouldn’t have any particular program rights as it relates to DISH. It doesn’t mean that DISH – it does not preclude DISH from somehow utilizing frequencies or technology that's provided by SATS or any other company for that matter in using their own programming agreements to use it. But, SATS wouldn’t have on its own programming agreements for them. They may have some but for the most part, it doesn't necessarily have programming agreements that allows it that kind of transmission. It does have some program agreements as it relates to slang [ph] and that technology, it does have – it is working with programmers to try to do something that in a way that protects those programmers copyright to say in a way that YouTube doesn't today. So they have their own contracts for that.

Okay. And in terms of CMB Star, what would the – I’m sure they’re bound up trying to make decisions to make the Olympics work and the air clean and things like that. What is the likelihood that you could sell them other excess capacity or was there something unique about CMB Star that made it particularly useful or relevant to China?

Well CMB star was designed for China. It was designed to their specification for them to use their S-band frequencies in conjunction with the nationwide mobile service. Obviously, China is similar to the United States, it has a lot of rural areas that just can’t get done from cities. So it was really designed that way, because China hasn’t fulfilled their obligations on the contract so far, right, we’re looking other alternatives for that satellite that we think there's an opportunity because of the kind of rural increased use of S-band and some timing issues where people could lose licenses in S-band, but there's some opportunities to reconfigure that satellite to a customer who can fulfill their obligations. And so we’re looking to the cost and the timing of doing that. And how long that would take and how much you it would cost and whether we have willing customers to do that. So I think the disclosures about where we are to date not to dissimilar than where we were last quarter, and I think probably within the next quarter, we’ll have to make decisions there.

Yes, you will speculate that China won't make a decision until the Olympics are over?

Again, we have to be prepared. I think our goal is to be prepared to move ahead without the Chinese.

Okay. Thank you very much.

The next question is a follow-up from the line of Chris Summer.

No, I don’t have a question.

Okay.

Your next question comes from the line of Chris Hill [ph].

Hi, I was just trying to understand where in terms of your CapEx budget, if I'm looking at your commitment to contingencies, where additional broadcast equipment would fit into that on a threshold [ph] that is non-satellite related purchases?

Give me a second, I believe DVO equipment would also be under purchase obligations to the extent we have any orders for our equipment that resides on our uplink center. We obviously know (inaudible) very far out, so they probably going to be part of that big lump that's in the big 2008 number.

Great, thank you.

The next question comes from the line of Sam Lash [ph]. Sam your line is open and you may proceed with your question.

Thank you. Could you clarify the CMB Star situation? Previously you’ve mentioned that the satellite will meet the specs of the standard – the Chinese standard, thereby sort of implying that it was a satellite issue or manufacturing issue, and now you are saying that China didn’t live up to their end of the agreement. I guess with respect to whatever operational or operating agreement that you had in place, so can you clarify, is it a satellite problem or a business relationship problem?

I think it's both. I think that the satellite hasn’t met the specs. We’re looking at ways for it to meet the spec. Therefore, the Chinese haven't – had to live up to their agreement but they said meet the spec. They would have to, but there’s no guarantee they would at this point. So it's a bit more complicated, and again, all we can do is be in position to use the satellite and make money at it.

Thank you.

At this time, there are no further questions. Thank you.

Okay. We’ll be back again in November. Thanks for joining us today.

This concludes today’s conference call. You may now disconnect.